Prudent person rules affect trustees

Financial planners, investment advisers, accountants, and all professionals who provide investment advice should be aware of the recent introduction of the prudent person rules where they affect the responsibilities of trustees. They should also ascertain the extent of their legal liability when advising trustees on investment strategy, in the event of subsequent poor performance of the trust.

Previously, trustees were limited to investing in authorised trustee investments, such as bank deposits, approved debentures, government bonds and property. A broadening of the rules, now applying in every state and territory, could represent a double-edged sword. On one hand it provides trustees with wider investment powers, but on the other, increases their exposure to risk of legal action if they are deemed to have acted inappropriately.

In the event of such litigation, there is a strong possibility that the trustee will in turn sue his or her financial adviser for mismanagement.

The prudent person rules can affect those responsible for a wide range of trusts, including inter vivos trusts, deceased estates, charities, superannuation funds, and government and semi-government organisations, such as schools, colleges and hospitals.

In general terms, when exercising investment powers, prudent investment requires trustees to be mindful of a number of considerations. These include:

the purposes of the trust, and the needs and circumstances of the beneficiaries;

the desirability of diversifying trust investments;

the nature and risk associated with existing trust investments and other trust property;

the need to maintain the real value of the capital or income of the trust;

the risk of capital loss or depreciation, and the potential for capital appreciation;

the likely income return and its timing; and

the length of a proposed investment, and the overall probable duration of the trust.

The nature and extent of the prudent person regime and trustee investment differs from state to state. Generally, the rules allow trustees of new and existing trusts to invest, reinvest or vary investment in any form of investment in any form of investment unless specifically forbidden under the terms of the trust.

Where a trust deed or document is silent as to investment powers, then it is the responsibility of the trustee to determine his or her investment powers under the Trustee Act in the applicable jurisdiction.

Under the prudent person regime, a trustee has a duty to diversify investments, and where there are life and remainder beneficiaries, trustees are required to balance the interests of income and capital beneficiaries.

Trustees are also required to consider the impact of inflation, as this can reduce the interests of both income and capital beneficiaries. This issue is of particular importance in relation to the assets of long-term trusts, where asset allocation strategy needs to consider risk/return over a long term. As a trustee may not have the option of retaining income for future years, protection against inflation can only be achieved by investments which have both income and the potential for capital growth.

Additionally, trustees must be mindful of the tax consequences flowing from investments, and carry out a full review of all investments at least annually.

Those who fail to do so may leave themselves open to potential action where beneficiaries can show the investments fell in value where the previous review was more than 12 months ago.

Finally, as a defence against potential action, trustees must:

make and keep extensive and meticulous written records of all assets;

minute all decisions which can be used to avert challenges from beneficiaries;

take responsibility for every decision in relation to the fund; and

fully document all decisions, particularly in relation to the appropriateness of the trust's investment strategy, and for individual investments made in accordance with that strategy.

While trustees have always been required to act prudently and be personally liable for any losses incurred due to a failure in responsibility, they were protected by the authorised trustee investment limitations. These broader prudent person rules require trustees - and their advisers - to more carefully consider all aspects of investments and their potential impact on a particular trust.

<I>Louise Biti is technical manager at RetireInvest.